Business Context and Reporting Period
International Bancshares Corporation, headquartered in Laredo, Texas, is a commercial bank holding company serving South, Central and Southeast Texas and Oklahoma, with significant cross-border activity involving Mexico. The company operates through banking and non-banking subsidiaries and reports as one segment. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010, compared primarily with the same periods in 2009 and December 31, 2009.
Financial Results and Position
| Metric | Three Months Ended June 30, 2010 | Three Months Ended June 30, 2009 | Change |
|---|---|---|---|
| Total interest income | $113.1 million | $134.2 million | (15.7%) |
| Net interest income | $83.4 million | $99.5 million | (16.2%) |
| Provision for loan losses | $1.4 million | $22.9 million | (93.7%) |
| Non-interest income | $49.4 million | $56.2 million | (12.1%) |
| Non-interest expense | $79.5 million | $85.2 million | (6.7%) |
| Net income | $34.0 million | $31.1 million | 9.2% |
| Net income available to common shareholders | $30.7 million | $27.9 million | 10.2% |
| Diluted EPS | $0.45 | $0.41 | 9.8% |
| Metric | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 | Change |
|---|---|---|---|
| Net interest income | $173.3 million | $197.7 million | (12.3%) |
| Provision for loan losses | $8.7 million | $35.1 million | (75.3%) |
| Non-interest income | $121.0 million | $98.2 million | 23.2% |
| Non-interest expense | $185.0 million | $155.4 million | 19.1% |
| Net income | $66.1 million | $68.7 million | (3.8%) |
| Net income available to common shareholders | $59.5 million | $62.2 million | (4.3%) |
| Diluted EPS | $0.87 | $0.91 | (4.4%) |
- Total assets were $11.31 billion at June 30, 2010, down 3.9% from December 31, 2009.
- Net loans were $5.45 billion, down 2.2%, reflecting weak loan demand. Total loans were $5.54 billion.
- Deposits increased 4.2% to $7.48 billion, while other borrowed funds declined 59.7% to $543.5 million.
- Cash and cash equivalents increased to $244.3 million from $224.6 million at year-end.
- Shareholders’ equity increased 3.5% to $1.46 billion.
- The allowance for probable loan losses was $90.4 million, or 1.6% of total loans, versus 1.7% at year-end. Total impaired loans increased to $122.0 million from $118.3 million.
- Six-month operating cash flow was a use of $31.6 million, compared with $1.4 million provided in the prior-year period. Investing activities provided $523.2 million, primarily from securities sales and loan reductions; financing activities used $471.8 million, principally from repayment of other borrowings.
- Capital ratios improved: leverage was 12.14%, risk-weighted Tier 1 capital was 18.80%, and risk-weighted total capital was 20.06% at June 30, 2010.
Material Changes Versus Prior Comparable Period
- Quarterly common earnings improved despite a 16.2% decline in net interest income, primarily because the provision for loan losses fell sharply and operating expenses declined.
- First-half common earnings declined 4.3% because lower net interest income and substantially higher operating expenses, including litigation and impairment charges, more than offset lower loan-loss provisions and securities gains.
- Six-month non-interest income included $30.8 million of net securities transaction gains, compared with $11.7 million in the prior-year period. Management stated that securities sales were used to reposition the investment portfolio.
- Non-interest expense included a $21.8 million litigation reserve related to an inherited LFIN tax dispute and $7.5 million of credit-related impairment on non-agency mortgage-backed securities. These items were not present in the prior-year period.
- Interest income declined because of lower taxable investment-security income and reduced loan balances. Interest expense declined primarily because of lower time-deposit costs and substantially lower other borrowings.
- Other borrowed funds were reduced using proceeds from mortgage-backed security sales. Deposits increased, although management reported continued competition requiring some deposits to be priced above market rates.
Guidance, Outlook, Risks and Unusual Items
The filing provides no formal earnings or financial guidance. Management stated that first-half results are not necessarily indicative of full-year or future results and that it believes the company is appropriately positioned for interest-rate changes. The company was liability-sensitive in the near-term repricing periods and asset-sensitive over longer periods.
- Management believes the allowance for probable loan losses is adequate and expects collateral and guarantor support to mitigate losses on impaired loans. However, economic weakness, collateral values, borrower repayment capacity and the timing of loan resolutions remain material uncertainties.
- The company reported no direct subprime-loan exposure but acknowledged that the broader financial crisis increased impaired loans and market volatility.
- Available-for-sale securities totaled $4.31 billion, including $4.14 billion of residential mortgage-backed securities. Level 3 securities totaled $50.1 million and were valued using discounted cash-flow assumptions, including estimated prepayments, defaults, loss severity and a 13% discount rate.
- The company had $201.1 million of junior subordinated deferrable interest debentures and $216.0 million liquidation preference of TARP-related Series A preferred stock. Treasury consent restricted certain repurchases and dividends; common stock repurchases remained subject to those limitations.
- A judgment had been entered against the company in the LFIN tax dispute. The company recorded a reserve and intended to evaluate an appeal and other mitigation measures. The ultimate amount and timing of any additional exposure remained uncertain.
- Other legal proceedings were considered by management to have remote or immaterial probable losses, although developments could change that assessment.
- The July 2010 Dodd-Frank Act may affect interchange-fee revenue, consumer-service revenue, deposit insurance costs and capital requirements. The filing states that the ultimate impact was uncertain and dependent on subsequent rulemaking.
- Additional risks include economic and financial-market conditions, interest-rate movements, regulatory changes, U.S.-Mexico trade activity, competition, funding costs, credit losses, securities impairment, tax proceedings and regulatory examinations.
Important Facts for Investors to Verify
- Whether impaired loans, charge-offs and the allowance for probable loan losses trend favorably or deteriorate after June 30, 2010.
- How much of first-half earnings depended on non-recurring securities gains and the effect of future securities repositioning.
- The final resolution, appeal status and potential cash or earnings impact of the LFIN-related tax dispute.
- Future credit-related impairment charges on non-agency mortgage-backed securities and changes in Level 3 valuation assumptions.
- The sustainability of deposit growth and the cost of deposits as competition and interest rates change.
- The effect of Dodd-Frank implementation on interchange income, consumer fees, deposit insurance expense and required capital.
- Compliance with TARP-related restrictions on dividends and share repurchases, as well as the timing and terms of any preferred-stock redemption.